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What Happens If You Can’t Pay? Part 2

Last post, I got a little too caught up in the fun of student loans and realized 900 words in that I hadn’t even gotten to the intended topic of the post yet. So I am going to hop right in here and start discussing what happens when you default on your student loan payments.

When you default on your loans, a lot of things happen. A lot of bad things. First off, the whole balance of the loan plus interest becomes due immediately. Whereas before, only the minimum payment was due each month, now you owe the whole amount right now! And if you can’t make those monthly payments, there’s no way you can pay off the whole thing. This process is called acceleration. The lender might also turn over your loan to a collection agency, who will attempt to wring the money out of you.

And there are a lot of ways for them to wring the money out of you! The federal government can have your employer garnish your wages. This means that money will be automatically deducted from your paycheck and sent to the government in order to pay back the defaulted loans. The government can garnish up to 15% of your after-tax wages, and they can do this without a court order. Lenders of private loans can have your wages garnished too, but they will need a court order.

Also, the government can withhold your federal and state tax refund. Instead of getting a nice tax refund, the IRS will hold your refund and instead have it apply to your defaulted student loan debt. The official term for this is a tax offset.

If you had difficulty with student loan payments before, imagine how much more difficult things will be when your wages are being garnished and your tax refund is taken from you.

Going into default on your student loans will also wreak havoc on your credit score. A credit score is a “statistically derived numeric expression of a person’s creditworthiness that is used by lenders to assess the likelihood that a person will repay his or her debts (Investopedia).” Your failure to repay your loans will be reported to credit bureaus, who will significantly lower your credit score. A bad credit score will make companies averse to lending to you, since are now seen as having a risk of not paying back your loans.

A bad credit score can make it difficult or impossible to get a home mortgage, a car loan, or any other type of loan, including a credit card. If you can get one of these, it will most likely have high rates and other unfavorable terms designed to protect the lender in case you default again. A bad credit score can affect you in ways other than your ability to take out loans. Landlords can deny your rental application because of poor credit. Utility companies could choose not to work with you, or make you pay a large deposit up front. Insurance companies will also do a credit check before issuing you a policy, meaning you may have to pay higher rates for car insurance, renter’s insurance, or homeowner’s insurance. These problems associated with a bad credit rating won’t go away once you get back on track with your student loans. Credit ratings take a long time to recover, and it will take years of financially sound living to return your score to a good rating.

This all seems pretty bad, right? Defaulting on your student loans can affect you in ways you wouldn’t even imagine. Who would think that you could be denied rental of an apartment because you failed to pay back your student loans? But that’s the way things operate in our world, and we need to be aware of the far-reaching consequences of defaulting on student loans.

And it doesn’t end here. When you default on your student loans, you can also be charged several other fees; late fees, collection fees, or even attorney fees and legal fees if the lender takes you to court (which they can and may very well do!).

If the financial obligations of paying student loans is overwhelming, they can be discharged in bankruptcy. However, I would not recommend this step. Getting your loans discharged through bankruptcy is extremely difficult, and there are many other consequences associated with declaring bankruptcy.

So, putting it all together we see that defaulting on your student loans will have a drastic effect on your life. If you were having financial trouble with your life before, going into default will end up making things even worse! The balance of your loan will increase with all the added fees, and the whole amount will be due immediately. Your credit score will tank, and you’ll have to deal with all the problems associated with that. Factor in the all the stress related, and we can see that it is a messy situation indeed. This is why it’s so important to think about your loans and take them seriously. No one wants to end up in this situation, yet many people do. As I said in the last post, you don’t want to be that 1 in 10 who will default on their loans.

The best method of avoiding default on your loans is to be smart about them. Don’t take a single cent more than you need. Plan out your payments, even when you are still in college. This will give you a better idea of the cost of your loans, and you can determine how much you could reasonably pay back.

On the other hand, if you are having difficulty paying your student loans, or have already defaulted, there is hope! The worst thing you can do is get discouraged and give up. In a later post, I will be covering what you can do if you are faced with such a situation.

I know I’ve thrown a lot of information at you in these posts, but I believe that in order to be effective with our loans we need to understand them outside and in. I think we’ve reached that point; now it’s time to get into the good stuff. The next few posts will cover some best practices for student loans. I intend to cover all walks of life, from high schoolers just looking at college and loans, to people who have graduated and are paying off their student loans right now. Student loans can really mess up your life, but they don’t have to. It’s all up to you.